Growth should stabilize in 2016

After easing off slightly in 2015, growth should stabilize in 2016. Household consumption should rebound after the effects of the Coronavirus epidemic that struck the country in the second quarter of 2015. Besides, Korean households will take advantage of the stimulus plan initiated by the government with notably measures to facilitate car acquisitions with lower taxes. However, household debt, which represents almost 145% of disposable incomes, will continue to slow activity. Investment, in particular in construction, is expected to remain dynamic. Companies will continue to benefit from budget support from the government. In responding to the slowdown recorded in 2015 and the slowdown in global trade, the government implemented several recovery plans. These include in particular fiscal exemptions, spending on infrastructure construction, financial support for the SME sector and measures aimed at strengthening social protection and the development of services. In addition, inflation is likely to remain below the central bank target, which will allow it to continue with its relaxed monetary policy. It cut (-50 bp) its policy rate twice in 2015 and once in 2016 (total of -75bp) to what is now an historic low. The Korean economy, strongly export orientated, will continue to be constrained in 2016 by the slowing of the Chinese economy which is the destination for a quarter of Korean exports. On top of this, the weaknesses of the yen and the euro work against Korean products.

The agriculture sector is expected to recover following the severe drought in the summer of 2015. There is likely to be some restructuring of companies, in particular in the shipbuilding sector, struggling under a heavy debt burden. Lastly, the Korean economy will remain at two speeds with the dynamic industrial conglomerates – the chaebols – but also a low-productivity service sector. Furthermore, the transparency of the chaebols, characterised by family control and hereditary succession, remains limited.

Financial situation under control

In 2015, the country recorded a small public deficit as a result of the exceptional expenditure during the summer. In 2016, despite a larger budget and a new stimulus plan, the public deficit should return to surplus. Public debt will remain sustainable and below the levels of most other OECD countries. Contingent commitments and SOE debt however respectively account for 10 and 30% of GDP.

The current account is expected to stabilize in surplus in 2016. The value of natural gas imports, oil and coal shouldn’t rebound thanks to low prices and this should help offset the impact of the slowdown in exports of goods and the worsening in the balance of services linked with the slowdown in China.In this context, FX reserves will remain at a satisfactory level (more than 9 month of imports), giving the country good resistance to any sudden capital withdrawals. As there was only a very limited impact on the won, compared to other Asian currencies, with the capital withdrawals seen in many emerging economies during the summer of 2013 and in 2015, the tightening of US monetary policy at the end of 2016 should not have a major impact on its value. The reasons for this can be found in the size of its current account surplus and the weak correlation between the Korean bond market and the global aversion in risk and other emerging bond markets. Finally, the high level of household debt does represent a risk for the banking sector.

Deterioration in relations with North Korea

The dangers of tensions with North Korea remain. Despite the desire for dialogue demonstrated by its President, Park Geun-hye and the adoption of a so-called “6 point” agreement in August 2015, relations between the two countries deteriorated early 2016. North Korea conducted a nuclear test in January and fired long-range rocket in February. Since then its rhetoric has been very aggressive. Repeated threats made by North Korea serve to illustrate the inherent instability of the relations between the two countries. As a result UN passed new sanctions in February 2016.

In terms of internal politics, further social conflicts are likely, in particular because of the precarious state of many workers and restructuring process in the naval industry. On top of this the President has been subject to criticism for her management of the Sewol shipwreck and the epidemic. As the Prime Minister resigned following the sinking, the President carried out a reshuffle in April 2014. The new Prime Minister, however, resigned in April 2015, following suspicions of corruption that forced Mrs Park to appoint the 3rd Prime Minister since the start of her term of office. Because of abundant criticism towards Park Geun-hye, the ruling party suffered a short defeat in the parliamentary elections of April 2016. Nevertheless it regained majority in National Assembly in June because 7 independent members returned to the party.